Recently there have been a number of articles in the news regarding bond risk. This article is a brief summary in response to issues raised in the media.
Generally these articles have referred to two potential risks:
- Interest rate risk that is the risk to bond prices as interest rates begin to move higher.
- Credit risk, the risk of investing in lower credit quality bonds with the aim of achieving a better return.
The aim of having an allocation to bonds is to incorporate the features and protections that bonds provide in times of market downturn in order to preserve capital and minimise volatility to the income generated from your portfolio.
While bond prices move up and down once they are issued and trading in the secondary market, assuming the company continues to operate, you will receive the face value (usually $100) back at maturity. As your bond moves closer to maturity it will drift back to face value which acts to minimise the price volatility. The chance of loss on investment grade bonds is very low.
Interest payments (known as coupons) on bonds are set at either a fixed rate, or in the case of floating rate bonds and inflation linked bonds, a fixed margin. They cannot be deferred and must be paid to bond holders. This protects the value and certainty of your income.
Those who invest in bonds indirectly via a managed fund, or in a listed hybrid, lose many of these features.
Investing through a managed fund means you only have a unit price for your holding, you no longer have the protection of a maturity date at which time you know the full face value will be paid back to you. Income is paid to the fund and the fund manager decides the interest payment paid as a distribution as the coupons are paid to the fund and not to you.
The managed fund’s unit price is subject to the cash flow needs of your fellow unit holders. It is calculated daily to reflect the value of the fund including any transactions and costs. So while you may be happy to hold your investment, if other investors want their money and the fund manager is required to sell assets, this will be reflected in the unit price and will impact the value of your investment.
Hybrids do not offer the same protections as bonds. If you only hold listed hybrids, you not only lose the protection of a maturity date but coupons can be deferred and holders of new style hybrids can be bailed-in to equity or have the investment completely written off.
By investing in an investment grade, diversified, direct bond portfolio, you retain all of the protections of bonds with the added benefit of complete transparency and control over your fixed income investments. Bonds are one of the few investments that can look forward to show exactly what your earnings will be, through your coupon payments and final maturity payment.
By incorporating a mix of fixed rate, floating rate and inflation linked bonds you can minimise the impact on your portfolio whatever future interest view emerges rather than try to anticipate future interest rate moves.
This is exactly what you want your fixed income allocation to provide for your investment portfolio. Both capital preservation and income stability, both of increasing importance as you transition to retirement.
Copyright The contents of this document are copyright. Other than under the Copyright Act 1968 (Cth), no part of it may be reproduced or distributed to a third party without FIIG’s prior written permission other than to the recipient’s accountants, tax advisors and lawyers for the purpose of the recipient obtaining advice prior to making any investment decision. FIIG asserts all of its intellectual property rights in relation to this document and reserves its rights to prosecute for breaches of those rights.
Disclaimer Certain statements contained in the information may be statements of future expectations and other forward-looking statements. These statements involve subjective judgement and analysis and may be based on third party sources and are subject to significant known and unknown uncertainties, risks and contingencies outside the control of the company which may cause actual results to vary materially from those expressed or implied by these forward looking statements. Forward-looking statements contained in the information regarding past trends or activities should not be taken as a representation that such trends or activities will continue in the future. You should not place undue reliance on forward-looking statements, which speak only as of the date of this report. Opinions expressed are present opinions only and are subject to change without further notice.
No representation or warranty is given as to the accuracy or completeness of the information contained herein. There is no obligation to update, modify or amend the information or to otherwise notify the recipient if information, opinion, projection, forward-looking statement, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.
FIIG shall not have any liability, contingent or otherwise, to any user of the information or to third parties, or any responsibility whatsoever, for the correctness, quality, accuracy, timeliness, pricing, reliability, performance or completeness of the information. In no event will FIIG be liable for any special, indirect, incidental or consequential damages which may be incurred or experienced on account of the user using information even if it has been advised of the possibility of such damages.
FIIG provides general financial product advice only. As a result, this document, and any information or advice, has been provided by FIIG without taking account of your objectives, financial situation and needs. Because of this, you should, before acting on any advice from FIIG, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If this document, or any advice, relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a product disclosure statement relating to the product and consider the statement before making any decision about whether to acquire the product. Neither FIIG, nor any of its directors, authorised representatives, employees, or agents, makes any representation or warranty as to the reliability, accuracy, or completeness, of this document or any advice. Nor do they accept any liability or responsibility arising in any way (including negligence) for errors in, or omissions from, this document or advice. Any reference to credit ratings of companies, entities or financial products must only be relied upon by a ‘wholesale client’ as that term is defined in section 761G of the Corporations Act 2001 (Cth). FIIG strongly recommends that you seek independent accounting, financial, taxation, and legal advice, tailored to your specific objectives, financial situation or needs, prior to making any investment decision. FIIG does not make a market in the securities or products that may be referred to in this document. A copy of FIIG’s current Financial Services Guide is available at www.fiig.com.au/fsg.
An investment in notes or corporate bonds should not be compared to a bank deposit. Notes and corporate bonds have a greater risk of loss of some or all of an investor’s capital when compared to bank deposits. Past performance of any product described on any communication from FIIG is not a reliable indication of future performance. Forecasts contained in this document are predictive in character and based on assumptions such as a 2.5% p.a. assumed rate of inflation, foreign exchange rates or forward interest rate curves generally available at the time and no reliance should be placed on the accuracy of any forecast information. The actual results may differ substantially from the forecasts and are subject to change without further notice. FIIG is not licensed to provide foreign exchange hedging or deal in foreign exchange contracts services. The information in this document is strictly confidential. If you are not the intended recipient of the information contained in this document, you may not disclose or use the information in any way. No liability is accepted for any unauthorised use of the information contained in this document. FIIG is the owner of the copyright material in this document unless otherwise specified.
The FIIG research analyst certifies that any views expressed in this document accurately reflect their views about the companies and financial products referred to in this document and that their remuneration is not directly or indirectly related to the views of the research analyst. This document is not available for distribution outside Australia and New Zealand and may not be passed on to any third party without the prior written consent of FIIG. FIIG, its directors and employees and related parties may have an interest in the company and any securities issued by the company and earn fees or revenue in relation to dealing in those securities.